RBI on the cutting edge

In the continuing tug-of-war between rising prices and sliding growth, the Reserve Bank of India (RBI) on Tuesday slashed key rates for the first time in nearly three years. HT explains the nuances of the growth-price-interest rate interplay. Gaurav Choudhury reports.

india Updated: Apr 18, 2012 03:20 IST

What has the RBI done?

It has slashed the repo rate by 0.50 percentage points to 8%.

What is repo rate?

It is the rate at which the RBI lends to banks.

How does repo rate influence interest rates that banks charge from customers? https://www.hindustantimes.com/Images/Popup/2012/4/18_04_12-buss27b.jpg

A lower repo reduces banks’ borrowing costs goading them to cut interest rates for final home, auto and corporate borrowers.

So, can consumers expect their EMIs to come down?

Not immediately. A lower repo will bring down costs for banks, but banks usually offer lower interest rates only for new customers. Besides, a lower interest rate does not necessarily mean EMIs will come down because the banks may first offer the option to change the tenure of the loans rather than reducing monthly installments.

What about loans on automobiles and consumer goods?

Automobile and consumer goods loans are all on fixed interest rates and, therefore, existing customers are not affected by changes in RBI’s policy rates.

What if I have an existing home and want to shift to a new loan offered by a different bank at a lower interest rate?

In a move that will bring relief to consumers, the RBI has said, henceforth, banks will not be permitted to levy foreclosure charges or pre-payment penalties on home loans on a floating interest rate. This implies that if you want to close an existing loan by borrowing from another bank as it is offering a lower interest rate, you would not be required to pay any penalty to the first bank.

What is reverse repo rate?

It is the rate at which the central bank borrows from banks to absorb or release cash from and into the system. It currently stands at 7.0%.

How does it influence banks’ lending rates?

At higher reverse repo, the central bank would suck cash from the system to stymie demand and cool prices. A lower reverse repo implies that banks would be encouraged to lend to other borrowers to earn more rather than park its funds with the RBI that will fetch lower returns.

What are policy rates? https://www.hindustantimes.com/Images/Popup/2012/4/18_04_12-buss27c.jpg

The policy rate acts the guide for final lending rates that banks charge from borrowers. In tight liquidity situations, the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts the policy rate.

What role do policy rates play in price control?

Till October, the RBI had raised the repo rate 13 times in 19 months to tame prices. A higher repo would raise banks’ borrowing costs, which in turn would raise interest rate on home, auto and corporate loans. A higher reverse repo would give banks incentive to park money with RBI, reducing liquidity and demand.

What prompted the RBI to slash policy rates?

The string of interest rate hikes may have tamed inflation but eroded growth in the broader economy. The industry has been demanding for lower interest rates, as corporations, squeezed by costly borrowing and input costs, have deferred planned capacity expansions.

Can we expect more interest rate cuts in the coming months?

If inflation remains high, the RBI may hold back further repo rate cuts. Wholesale price index (WPI)-based inflation, India’s most watched cost of living index, was at 6.9% in March, but likely to go up in the coming months following the announcements made in the budget last month.

How will budget announcements push up inflation?

In the budget, finance minister Pranab Mukherjee had raised excise duty by two percentage points to 12% for most manufactured goods and added more services that will be taxed. This will make most services and manufactured goods such as cars and consumer durables costlier.

First Published: Apr 17, 2012 22:36 IST